Bank Underground

Looking inside the ledgers: the Bank of England as a Lender of Last Resort

Michael Anson, David Bholat, Miao Kang and  Ryland Thomas

Imagine if you could peek inside the Bank’s historical ledgers and see the array of interest rates the Bank has charged for emergency loans in the past. If you could get the inside scoop on how many of these loans were never repaid, and how that impacted the Bank’s bottom line? Now you can.  We have transcribed the Bank’s daily transactional ledgers and put them into an Excel workbook for you to explore. These ledgers contain a wealth of information on everyone who asked the Bank for a loan during the 1847, 1857 and 1866 crises.

The data records who applied; whether their requests were accepted or rejected; the value and volume of assets they exchanged for cash; as well as the price (interest rate) at which they did so. Besides the ledger data, our Excel workbook includes granular data on the Bank’s balance sheet and income statement.

Figure 1 Turning ledgers (left) into data (right)

These data lie at the heart of a recently published Staff Working Paper exploring the Bank of England’s role historically as a lender of last resort. The paper analyses the extent to which the Bank adhered to Walter Bagehot’s dictum that a central bank during financial crises should lend cash freely at a penalty rate in exchange for ‘good security’ in the period before Bagehot published his book Lombard Street.

Lending freely

During the crises of the nineteenth century, the Bank would provide financial markets with liquidity by purchasing ‘packets’ of bills of exchange. These packets were like modern day CDOs in that they bundled together various bills. The Bank’s Discount Office would typically discount the bundle at a single rate of interest, sometimes at two. For example, Figure 2 shows that on 23 October 1847, Overend Gurney brought in a packet of 80 bills with a face value of £68,460 and got a loan at 9 percent discount. They walked away with £62,299, just under £6 million in today’s terms.

Figure 2: Excerpt from the Bank’s ledgers. Transaction with Overend Gurney highlighted.

Figure 3: Bank of England lending to private sector counterparties as a percent of the Bank’s total assets

Figure 3 charts the Bank’s lending to the private sector between 1844 and 1870. It shows that the Bank acted as a lender of last resort during the 1847, 1857 and 1866 crises by lending more freely, at least relative to non-crisis years.

However, the Bank’s generosity fell unevenly— typically the top fifth of borrowers received over three-fourths of the amounts lent (Figure 4). However, we have found no evidence that the Bank preferred lending to its existing customers i.e. those who held current accounts with the Bank’s Drawing Office, versus others. In fact, Figure 5 shows that the Bank’s current account holders, which included the Government and a wide variety of individuals and institutions, were slightly less successful in getting bills purchased by the Discount Office.

Figure 4: Distribution of discounts across the three crises

Figure 5: Loan application success rate split by Drawing Office and non-Drawing Office customers

So who got loans from the Bank? Figure 6 lists the Bank’s top five counterparties by loan value during each of the crises. Some counterparties appear across years. For example, Overend Gurney makes the top five in 1847 and 1857 but, fatally, not in 1866, when its failure caused a crisis much like Lehman’s did in 2008.

But getting money from the Bank by no means assured survival. Firms that are highlighted defaulted. Some were two-time losers. For example, Bruce and Co, and Sanderson and Co, defaulted in 1847, reconstituted themselves with slightly different partners…but failed again in 1857.

Note also the variety of institutions to whom the Bank lent. Unlike in 1866 when most counterparties were banks, in 1847 and ‘57 the Bank mostly lent to non-bank counterparties such as discount houses, institutions whose balance sheets most closely resembled those of shadow banks today.

Figure 6 The Bank’s top five counterparties during crisis years

Interest rate evidence

Before the 1840s, the Bank rarely changed its discount rate, in accordance with usury laws which capped interest rates at 5% from 1714 until 1833. However, once those laws were repealed, the Bank moved its headline rate much more frequently and to greater heights (Figure 7).

Figure 7 Bank Rate before and after 1833

But Bank Rate tells only part of the story. The rest comes to light when we dig into the ledger data. For example, Figure 8 shows the spectrum of rates the Bank charged different customers in 1847. We see that some bills were actually discounted below Bank rate. More generally, Bank Rate was below those prevailing in the market.

Figure 8 Spread of discount rates in 1847

However, by 1866, the situation reversed (Figure 9). Bank Rate was now usually higher than market rates, conforming to Bagehot’s penalty rate rule a few years before he coined it.

Figure 9 Spread of discount rates in 1866

Evidence on good security

Bills of exchange were uncollateralised debts. So the ‘goodness’ of these securities was bound up with the individuals and institutions who had endorsed them, as well as the ultimate debtor on whom they had been drawn. While the daily discount ledgers do not provide these details, the Bank’s customer “with and upon” ledgers do. Thumbing through these ledgers, we see that debts drawn on a wide variety of industries were considered ‘good’ names. These include cabinet makers, cape merchants, flax spinners, publishers and umbrella manufacturers. And these debts originated from all corners of the globe, from Birmingham to Bombay, Canton to Cape Town.

Perhaps the best proof that the bills the Bank bought were good is the low levels of bad debt on its books. As Figure 10 shows, write-offs were rare. While late payments spiked around crises, their overall level even then was at or below 1% in 1857 and 1866.

Figure 10 Write-offs and late payments on the Bank’s books

The low levels of bad debt we observe in the data may reflect the global diversification of the Bank’s bills book, as well as their short maturity. Figure 11 shows that the average maturity of bills discounted hovered just above 60 days between 1849 and 1870, never coming close to breaching the Bank’s risk limit of 95 days’ tenor.

Figure 11 Average maturity of bills of exchange bought by the Bank

Above all, the proof of the ‘goodness’ was in the profits. The Bank reaped rewards from the greater risks it ran from acting as a lender of last resort during financial crises. Figure 12 shows that interest income from bills discounted increased in the reporting periods immediately following each of the three crises, reflecting the greater quantity of bills the Bank was discounting during crises, and the higher interest rate it was charging for doing so. Increases in interest income in turn increased profits.  Since the Bank paid all of its profits as dividends at this time, this was a boon to shareholders. In February 1848, following the 1847 crisis, and February 1858, following the 1857 crisis, profits and therefore dividends increased nearly 18% year-on-year. In August 1866, after Overend Gurney’s crisis in May that year, profits and dividends went up nearly 38% year-on-year. Like gold today, Bank of England stock was a counter-cyclical asset.

Figure 12 Profits and interest income from bills discounted, 1845-1870

Now we need your help

In sum, we find that the Bank developed into a textbook lender of last resort over the course of the three great crises of the mid-nineteenth century. Strikingly, it did so before Bagehot wrote his canonical text.

But our paper barely scratches the surface of the historical treasures buried below Threadneedle Street in the Bank’s archives.

You can unearth more.

Today we are launching a website where you can help transcribe more ledger data. For those who like to code, we’ve also created a GitHub page where we’ve published an in-process machine learning algorithm to automate the transcription of ledger data. In this way, we hope to bring the tools of tomorrow to bear on the Bank’s past in a way that hopefully informs contemporary debates about the role central banks play as lenders of last resorts.

David Bholat and Miao Kang work in the Bank’s Advanced Analytics Division.

Michael Anson works in the Bank’s Archive Division.

Ryland Thomas works in the Bank’s Monetary Assessment and Strategy Division.

If you want to get in touch, please email us at bankunderground@bankofengland.co.uk or leave a comment below.

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Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.